There is no single best way to invest $100,000 -- owing to the time value of money, what works for a 25-year-old is inappropriate for a retiree. While some investors have a relatively high tolerance for risk, others need safer investments with reliable returns. A $100,000 sum could make up one person's entire investing capital while being only 10 percent of another's. Regardless, investment diversity is key, and choosing just one vehicle to invest the entire $100,000 could end badly. Some general portfolio investment principles have wide applicability and can help guide your investment decisions.
Risk, Volatility, Diversification and Cost
Investors should aim to keep investment risk to the minimum necessary for a desired return. One way of doing this is to reduce the portfolio's volatility. by diversifying investments. While beginning investors often invest heavily in one or two currently hot stocks, this is misguided. The portfolio should contain many different investments, with a minimum of correlation among them -- investments that are unlikely to rise and fall in value together. Finally, your management and other investment costs should be kept to a minimum. Since the average stock market return over the long run is around 9 percent per year compounded, a portfolio with 3 or 4 percent management costs will likely significantly underperform a portfolio with management costs of 1 percent or better.
Younger Investor's Portfolio: Bonds
Younger investors can reasonably take on a little more risk than older investors. If you are investing for retirement in 40 years, you can handle the market ups and downs better than a retired investor who may not have time to recover from a large market loss. A reasonable portfolio for a younger investor might be 90 percent stocks and 10 percent bonds. Each decade the bond percentage could rise another 5 or 10 percent, depending on the investor's risk tolerance. Government bonds and investment grade commercial bonds present lower volatility, hence lower risk, than stocks. As the investor ages, bond maturities should be shortened. While bonds and stocks are not completely uncorrelated, a portfolio with both will be less volatile than a portfolio composed entirely of stocks.
Younger Investor's Portfolio: Stocks
To reduce the correlation of the portfolio, some stocks, perhaps 75 percent or more if the investor is particularly concerned with risk, should be in domestic stock equities with the remainder in foreign stocks. A portfolio made up of the lowest-cost index funds keeps management costs to a minimum. While some high-flying mutual funds have management fees totaling 3 or 4 percent, index exchange-traded funds from a low-cost source, such as Vanguard or Fidelity, will have management fees of 0.25 percent or less. Divide your ETFs into value, growth and foreign funds. You may also want to further divide your funds into large-cap funds -- funds with $10 billion or more invested -- and small-cap funds. All these divisions increase diversification and reduce correlation.
Older Investor's Portfolios
As an investor approaches retirement, volatility and risk should be further reduced. A retiree, for example, might have a portfolio almost evenly divided between stocks and bonds. A portion of the portfolio should be left in equities that can be immediately liquidated with little risk -- money market funds and short-term Treasuries. How much of the portfolio should be in these safest investments depends upon the investor's risk tolerance, other resources and health; investors with health problems need to be able to access funds for medical costs. An older investor who owns his own home with a paid-up mortgage can afford a little more risk than a renter or an owner with a mortgage payment.